NEW DELHI, Feb 28 (Reuters) - India unveiled a surge in government spending on Thursday, despite expectations of an austerity budget to shore up its finances, imposing new taxes on the rich and large companies to fund a dash for growth ahead of an election due by next year.

The extent of the slowdown gripping Asia’s third-largest economy was underlined by data released just hours after Finance Minister P. Chidambaram delivered his budget for the coming fiscal year, showing GDP growth tumbled to 4.5 percent in the October-December quarter, its lowest in nearly four years.

Chidambaram, whose reformist zeal has made him a darling of financial markets since his appointment last August, focused on revenue-raising measures rather than spending cuts, a sign, analysts said, of his difficult balancing act ahead of a general election that must be held before the middle of next year.

Many private economists expressed scepticism at Chidambaram’s rosy revenue assumptions and were dismayed by the sizeable increase in public spending in a country facing its sharpest economic downturn in a decade.

Total budget expenditure will rise by 16 percent in the 2013/14 fiscal year to 16.65 trillion rupees ($309 billion).

Investors have until now cheered on the energetic and forceful Chidambaram for his efforts to shore up India’s finances by hiking fuel prices, opening up the retail and airline sectors to foreign players and curb government spending.

But stocks, bond prices and the rupee all fell on Thursday, despite his vow to cut the fiscal deficit to 4.8 percent of gross domestic product (GDP) in the year starting April 1.

“The honeymoon is over,” BNP Paribas said in a critique that questioned his budget arithmetic. “The finance minister ... has pencilled in a capex boom, financed by populist tax hikes on the rich, a sharp pickup in disinvestment proceeds and, that old friend, implausible control of subsidy spending.”

The budget did achieve Chidambaram’s immediate goal of staving off a credit rating downgrade, for now. Global agencies Standard & Poor’s (S&P) and Fitch said the budget would not affect their assessment of India’s creditworthiness. Both have threatened to downgrade India’s sovereign rating to “junk” unless it gets it finances under control.

There had been widespread expectations, fuelled in part by comments by finance ministry officials, that Chidambaram would present an austere budget to parliament. But the spending plan appeared to have been drawn up with voters in mind, several economists and industrialists said.

The coalition government led by Sonia Gandhi’s Congress party, mired in corruption scandals and widely derided as incompetent in the face of the economic slowdown, faces a struggle for re-election in polls due by May 2014.

“With a general election not much (more) than a year away, political pressure from within the Congress Party may well have had an influence on the make-up of the finance minister’s budget,” Credit Suisse said.

REPUTATION ON THE LINE

Chidambaram, a three-time finance minister seen as a potential candidate for prime minister in 2014, has staked his reputation on cutting swollen fiscal and current account deficits that have alarmed the rating agencies.

“Faced with a huge fiscal deficit, I had no choice but to rationalise expenditure,” he said in his budget speech, which was seen as a balancing act to avert a downgrade while meeting his party’s demands for vote-winning spending. “We took a bitter dose of medicine. It seems to be working.”

Next year’s fiscal deficit target is in line with expectations but assumes hefty revenue growth, including 558 billion rupees from the sale of government stakes in companies, more than double the 240 billion rupee target for the current year, which falls short of the initial target.

The budget also assumes revenue of 408.5 billion rupees from telecoms sector fees, more than double what it will generate this year, with its next auction of mobile airwaves poised to flop after attracting just one bidder.

“The government may fall short of its tax and disinvestment targets and end up cutting spending closer to the end of the year to attain its fiscal deficit target,” said A. Prasanna, economist at ICICI Securities Primary Dealership Ltd.

Net market borrowing of 4.84 trillion rupees for the new fiscal year met investor hopes that the figure would not top 5 trillion rupees, but the gross figure exceeded expectations.

The budget included several measures to spur investment both in markets and by corporations, including an incentive on investments in plant and machinery exceeding 1 billion rupees and extending tax breaks for small companies that grow larger, and an expansion of tax-free bonds for infrastructure.

“India, at the present juncture, does not have the choice between welcoming and spurning foreign investment,” he said.

However, the budget disappointed foreign investors by failing to deliver a much anticipated cut in withholding taxes for debt investments and creating confusion with a proposal that appeared to target tax treaties.

HEY, BIG SPENDER

While the added spending included capital investment that many have said is sorely needed, including a 29 percent increase in funding for infrastructure and development, it also included a 46 percent jump in funding for development programmes in rural areas, the core voter base of the ruling Congress party.

Chidambaram also hiked the farm ministry’s budget by 22 percent, and promised to increase targeted farm loans to 7 trillion Indian rupees ($129.92 billion), from 5.75 trillion rupees in 2012/13.

He made a smaller-than-expected commitment to food subsidies, less than 1.2 trillion rupees the food minister said two weeks ago that India might have to spend.

An added surcharge on local firms with incomes of more than 100 million rupees and a 10 percent surcharge on individuals with annual taxable incomes topping 10 million rupees ($185,000) - a level of earnings currently declared by just 42,800 people - will be put in place for one year.

Dozens of corporate executives, watching a telecast at an industry event in New Delhi, exchanged nervous smiles as Chidambaram introduced the surcharge on the rich.

“In the larger scheme of things, I guess that is one way of reducing his deficit. Am I going to lose sleep over it? No,” Ganesh Natarajan, CEO of IT outsourcer Zensar Technologies , said by phone from Pune, where the company is based.